Van Eck, Merrill Partner: Conversion of HOLDRS Ahead?

by on August 15, 2011 | ETFs Mentioned:

Van Eck announced last week a partnership with Merrill Lynch that may ultimately lead to the conversion of several HOLDRS products to soon-to-be-launched Market Vectors ETFs. As part of the agreement, Van Eck will introduce six new ETFs that maintain the same tickers as the existing HOLDRS but that will be part of the Market Vectors family of ETFs. Van Eck said it expects the exchange to be launched in the third quarter of this year and consummated in the fourth quarter.

The agreement would cover six existing HOLDRS, which would be converted to Van Eck ETFs that seek to replicate Market Vectors indices. The impacted products include:

Ticker New Market Vectors ETF Underlying Index
OIH Oil Services ETF Market Vectors US Listed Oil Services 25 Index
SMH Semiconductor ETF Market Vectors US Listed Semiconductor 25 Index
PPH Pharmaceutical ETF Market Vectors US Listed Pharmaceutical 25 Index
BBH Biotech ETF Market Vectors US Listed Biotech 25 Index
RTH Retail ETF Market Vectors US Listed Retail 25 Index
RKH Money-Center Bank ETF Market Vectors US Listed Money-Centre Bank 25 Index

Merrill Lynch currently offers 17 HOLDRS that have aggregate assets of nearly $5 billion. OIH, which has more than $2.5 billion in AUM, is by far the largest member of the family. The other five HOLDRS covered by this deal are also among the largest in the lineup, and the six products combine to account for about 90% of total HOLDRS assets. There was no mention of any plans to convert the remaining products, which would have aggregate assets of about $500 million, to Van Eck ETFs.

HOLDRS have been slowly bleeding cash over the last several years. Net outflows averaged $1 billion annually in 2009 and 2010, and close to $180 million for the first seven months of 2011.

Van Eck’s ETP assets totaled more than $24 billion at the end of June. The company currently offers 35 ETFs and four currency ETNs.

If ultimately carried out, the conversion would be more than just a cosmetic change to the products in question. The Market Vectors indexes to which the new ETFs would be linked exhibit some overlap with the holdings of the existing HOLDRS, but are generally more diversified and less concentrated. As the names of the new indexes suggest, each new ETF would include about 25 stocks in the related industry. Currently, many of these funds have far fewer than 25 components stocks:

Ticker # of Holdings Largest Holding Weight
OIH 14 Schlumberger 18.6%
SMH 18 Texas Instruments 21.1%
PPH 14 Johnson & Johnson 23.9%
BBH 10 Amgen 34.8%
RTH 18 Wal-Mart 17.5%
RKH 17 JPMorgan 22.4%
*As of 8/3/2011

Under The Hood Of HOLDRS

The conversion to ETFs would also involve a significant structural change. HOLDRS generally function in the same manner as traditional ETFs; they can be traded throughout the day, and the creation/redemption mechanism in place keeps prices in line with the NAV. But while HOLDRS are generally included under the ETF umbrella (and in our database of ETFs), they are different in many ways from true 1940 Act exchange-traded funds. Besides the significant concentrations (which generally results because the underlying portfolios are never rebalanced), HOLDRS feature unique expense structures, voting rights, and creation/redemption policies [see Five Facts About HOLRDS Every ETF Investor Should Know].

“We believe ETFs offer significant advantages over HOLDRS in their ability to evolve with a dynamic underlying index; this in turn leads to enhanced diversification and broader-based representation of a market or industry segment,” said Adam Phillips, Managing Director of ETFs at Van Eck. “We are pleased to have been chosen by Merrill Lynch to partner with them in this important transaction.”

When the conversion to Market Vectors ETFs is complete, investors in these funds will continue to enjoy all the benefits of the ETF structure without the quirky nuances of HOLDRS. Some HOLDRS have only a small handful of individual holdings, and BHH now consists of just two stocks–with one making up about 90% of the portfolio [see The Curious Case Of The B2B Internet HOLDRS].

Disclosure: No positions at time of writing